The capital structure of multinational companies under tax competition

This article studies the relation between debt policies of multinational companies (MNCs) and governments’ tax strategies. In the first part, we show that the ability to shift income from high- to low-tax countries affects MNCs’ financial choices. In the second part we show how MNCs’ financial decisions can affect the tax strategies of two governments competing to attract income.      

The welfare loss from differential taxation of sectors in Germany

In the spirit of Harberger, we apply a dynamic computable general equilibrium (CGE) model and estimate the excess burden stemming from the tax-induced distortion in the allocation of capital across the corporate and the non-corporate sectors in Germany. In doing so, we perform a counterfactual analysis and ask how the allocation of capital across sectors would change compared with a sector-neutral tax system which assures an identical effective tax burden on both sectors. Our estimates suggest that the excess burden per-period amounts to approximately 2.2 billion Euros or to about 0.1 per cent of GDP. In present value terms, the excess burden translates to about 89 billion Euros or 4.0 per cent of GDP. In order to identify the impact of the firm’s financial behaviour on the size of the emerging excess burden, we perform several sensitivity analyses with regard to debt financing, external equity financing and debt constraints via agency cost.     

Concavity of utility,concavity of welfare,and redistribution of income

The marginal social value of income redistribution is understood to depend on both the concavity of individuals’ utility functions and the concavity of the social welfare function. In the pertinent literatures, notably on optimal income taxation and on normative inequality measurement, it seems to be accepted that the role of these two sources of concavity is symmetric with regard to the social concern about inequality in the distribution of income. Direct examination of the question, however, reveals that this is not the case. Concavity of utility has a simple, direct effect on the marginal social value of redistribution, as might be expected, whereas concavity of the social welfare function has a more subtle influence, one that in some cases may not be very significant. The implications of this difference are examined for some standard forms of utility and welfare functions, including particular versions that appear in the optimal income taxation literature.     

FDI determination and corporate tax competition in a volatile world

This paper investigates the impact of economic and political volatility on corporate tax rates on a large dataset of countries over the 1983–2003 period. Estimation of a dynamic tax rate equation supports the hypothesis that economic volatility negatively affects statutory corporate tax rates, while political volatility has no significant effect. In order to identify the channels through which volatility works, we estimate a structural model allowing for simultaneous determination of corporate tax rates and FDI inflows, and find that economic volatility affects the corporate tax setting process through its impact on FDI inflows.     

Tax competition and the international distribution of firm ownership: an invariance result

How does the international distribution of firm ownership affect the outcomes of tax/subsidy competition for mobile plants? As corporate ownership becomes increasingly globalised, this question becomes increasingly important for policy. We prove a strong invariance result in the context of the tax/subsidy competition between two host countries for a monopoly firm’s plant. Both the equilibrium plant location and the equilibrium tax/subsidy offers are independent of the international distribution of the firm’s ownership. The reason is that the tax/subsidy competition equalises the firm’s post-tax profits across countries, making owners of capital indifferent towards the location of production.     

Discussion of “The impact of product market competition on the quantity and quality of voluntary disclosures”

Li (2010, this issue) examines how product market competition affects voluntary disclosure by firms. Using several competition proxies, she finds that both the competitive threat from potential entrants into an industry and from existing rivals affect the quantity and accuracy of voluntary profit and investment forecasts by firms in that industry. However, the study’s findings are inconclusive mainly because each competition proxy used can reflect both types of competitive threat. The focus of my discussion is to provide some comments and suggestions for future researchers to consider in examining how the nature of product market competition affects voluntary firm disclosure.     

Optimal lifetime consumption and investment under a drawdown constraint

We consider the infinite-horizon optimal consumption-investment problem under a drawdown constraint, i.e., when the wealth process never falls below a fixed fraction of its running maximum. We assume that the risky asset is driven by the with constant coefficients. For a general class of utility functions, we provide the value function in explicit form and derive closed-form expressions for the optimal consumption and investment strategy.      

The economics of the welfare state in today’s world

This article is concerned both with the substantive policy issue of the implications of the European welfare state in a global setting and with the way in which economists analyse the welfare state. Economics has made a major contribution to our understanding of the welfare state through the provision of formal models. These have allowed us to see the implications of social protection for countries increasingly open to international competition. These models, however, leave out essential elements, and the standard Heckscher–Ohlin 2-good, 2-factor, 2-country assumptions impose too tight a straitjacket. We do not observe full factor price equalisation. The paper considers how we might relax this straitjacket to incorporate elements that are important in the public debate, while preserving tractability. The resulting 3×3×3 model is used to investigate the impact of globalisation on the welfare state, contrasting Europe and the US. The first version of this paper was written while I was visiting the Economic Research Department of the Bank of Italy. I am most grateful to the Research Department for their hospitality, but make clear that the contents of the paper are solely my responsibility. The paper was presented at the April 2006 Netspar Conference in the Hague. I thank the discussants, André de Jong and Cees Oudshoorn, and the conference participants, for their helpful comments. The revision has benefited from the valuable suggestions of the referees and editors, and the final version has been greatly improved as a result of a conversation with Peter Neary. None of the above are to be held responsible for the remaining shortcomings of the paper.     

The weak human and the saving grace of the welfare state: German pupils’ perception of future social change and drivers of change

Social change has often been seen as a desired goal of critical pedagogy. Interestingly; there is little research about how pupils in Germany perceive the concept of social change and what drives social change. This article presents the outcome of a three year long research project that aimed to analyse how a sample of German pupils makes sense of social change and what forces drive social change in society through future narratives (written assignments and interviews). The study finds that pupils have an implicit and explicit understanding of politics and the state as a driving force, but that this is challenged by external drivers such as the global economy/technology and internal drivers such as human self-interest/egoism and insecurity/fear. In this study, the pupils often describe the present economy as being organised and the future economy to become more and more disorganised. Using future narratives in critical pedagogy can be a way to work more closely with the students and their perceptions of social change and drivers of change.     

Does competition for capital discipline governments? The role of fiscal equalization

This paper examines how a fiscal equalization system affects the disciplining effect of competition for capital among heterogeneous regions in a decentralized economy. I build a model in which regions that are heterogeneous in initial endowments try to attract capital by competing public input that enhances the productivity of capital; meanwhile, a fiscal equalization system is imposed by the central government to reduce regional disparities in fiscal capacity. The key prediction, borne out in data from the German equalization system, is that while competition for capital strengthens discipline in the well-endowed regions, it weakens discipline in the poorly endowed regions. However, a conventional equalization transfer scheme, common to many countries, can be effective in correcting the distortion driven by the heterogeneity of initial endowments across competing regions.     

The relationship between banking market competition and risk-taking: Do size and capitalization matter?

This paper addresses the effects of bank competition on the risk-taking behaviors of banks in 10 Latin American countries between 2003 and 2008. We conduct our empirical approach in two steps. First, we estimate the Boone indicator, which is a measure of competition. We then regress this measure and other explanatory variables on the banking “stability inefficiency” derived simultaneously from the estimation of a stability stochastic frontier. Unlike previous findings, this paper concludes that competition affects risk-taking behavior in a non-linear way as both high and low competition levels enhance financial stability, while we find the opposite effect for average competition. In addition, bank size and capitalization are essential factors in explaining this relationship. On the one hand, the larger a bank is, the more it benefits from competition. On the other hand, a greater capital ratio is advantageous for banks that operate in collusive markets, while capitalization only enhances the stability of larger banks under high and average competition. These results are of extreme importance when considering bank regulations, especially in light of the recent turmoil in the global financial markets.     

The tactical and strategic value of hedge fund strategies: a cointegration approach

This paper analyzes long-term comovements between hedge fund strategies and traditional asset classes using multivariate cointegration methodology. Since cointegrated assets are tied together over the long run, a portfolio consisting of these assets will have lower long-term volatility. Thus, if the presence of cointegration lowers uncertainty, risk-averse investors should prefer assets that are cointegrated. Long-term (passive) investors can benefit from the knowledge of cointegrating relationships, while the built-in error correction mechanism allows active asset managers to anticipate short-run price movements. The empirical results indicate there is a long-run relationship between specific hedge fund strategies and traditional financial assets. Thus, the benefits of different hedge fund strategies are much less than suggested by correlation analysis and portfolio optimization. However, certain strategies combined with specific stock market segments offer portfolio managers adequate diversification potential, especially in the framework of tactical asset allocation.

The ‘competition–stability/fragility’ nexus: A comparative analysis of Islamic and conventional banks

The ‘competition–stability/fragility’ nexus is one of the more debated issues in the banking literature. However, while there is ample evidence concerning the relationship between competition and stability/fragility in different countries and regions, no prior study investigates this in the context of Islamic and conventional banks. We do this using data on both types of banks drawn from 16 developing economies over the period 2000–12. We measure the lack of competition using the Lerner index, and stability using both accounting-based measures, comprising the Z-score and the nonperforming loan ratio, and market-based measures, including Merton's distance to default. We employ panel vector autoregression and two-stage quantile regression to estimate the relationship. Our results lend support to the competition–fragility hypothesis in both Islamic and conventional banks. We also find the magnitude of the market power effect on stability is greater for conventional banks than Islamic banks. Lastly, banks in the median quantile of stability have a greater ability to reduce credit risk through gaining market power than banks in the lower and upper quantiles.     

The role of the corporate income tax as an automatic stabilizer

This paper analyses the effectiveness of the corporate income tax as an automatic stabilizer. It employs a unique firm-level data set of German manufacturers combining financial statements with firm-specific information about credit market restrictions. The results show that approximately 20 per cent of all firms report both positive taxable income and capital market restrictions. Taking account of the income tax rates and the size differences of the firms, we find that demand stabilization through the corporate income tax amounts to about 8 per cent of an initial shock to gross revenues. This stabilization effect varies over the business cycle and tends to increase during cyclical downturns.     

Efficiency of capital taxation in an open economy: tax competition versus tax exportation

Tax competition and tax exportation have contrary implications for the efficiency of capital taxation. We provide a simple condition for the dominance of either force, which depends on the mobility of foreign investment. We use this condition to evaluate the relative importance of both forces in the US and in the EU. This paper has benefitted substantially from the comments of the editor, Jay Wilson, and three anonymous referees.     

Personal taxes and the time variation of stock returns – evidence from the UK

A potential explanation for the time-series predictability of market returns with dividend yields is the differential tax treatment of capital gains and dividends. This article investigates to what extent the predictability of long-horizon returns can be explained by this tax effect. Assuming that after-tax expected returns are constant, we test the derived relationships between pretax returns and lagged dividend yields with UK data. We also compare the predictability of before-tax long-horizon returns with that of after-tax returns. The results indicate that the tax treatment of dividends does not significantly contribute towards the predictability of stock returns.     

The role of creative strategy,ad disclosure and regulatory focus in investors’ decision making: An experimental investigation

This study examines the effects of creative strategy and ad disclosure in financial services advertising (FSA) and individual differences in regulatory focus on retail investors’ attitudes and behavioral intentions. Results from a between-subject experiment indicate that investors’ regulatory focus (promotion focus versus prevention focus) moderates the effects of FSA related to creative strategy and ad disclosure. Specifically, prevention-focused investors (promotion-focused investors) had more favorable attitudes towards and showed greater purchase intentions of a financial product when exposed to informational ads and ads with disclosures (transformational ads and ads without disclosures). The authors offer theoretical, managerial and public policy implications.     

An applied analysis of ACE and CBIT reforms in the EU

We assess the quantitative impact of two reforms to corporation tax, which would eliminate the differential treatment of debt and equity: the allowance for corporate equity (ACE) and the comprehensive business income tax (CBIT). We explore the impact of these reforms on various decision margins, using an applied general equilibrium model for the EU calibrated with recent empirical estimates of elasticities. The results suggest that, if governments adjust statutory corporate tax rates to balance their budget, profit shifting and discrete location render CBIT more attractive for most individual European countries. European coordination makes a joint ACE more, and a joint CBIT less efficient. A combination of ACE and CBIT is always welfare improving.     

The value of power-related options under spectrally negative Lévy processes

Review of Derivatives Research - We provide analytical tools for pricing power options with exotic features (capped or log payoffs, gap options etc.) in the framework of exponential Lévy...